Some advisers eagerly await SEC’s OK of muni ETF

PHILADELPHIA — An exchange traded fund that invests in municipal bonds is expected finally to become a reality — a prospect that excites some financial advisers. Barclays Global Investors of San Francisco has registered to offer the iShares S&P National Municipal Bond Fund. If the Securities and Exchange Commission OKs it as expected, it will track the yet-to-be-released Standard & Poor’s National Municipal Bond Index. The ETF makes sense to advisers. “I think it’s excellent,” said Marvin Appel, chief executive of Appel Asset Management Corp., a Great Neck, N.Y., firm with $50 million in assets under management. “Any low-cost vehicle that invests in muni bonds is a good opportunity for any individual in a high tax bracket.” Muni bonds are tax exempt, and capital gains are treated as normal income, making them particularly attractive to the wealthy. “We would definitely be interested in this,” said Jim King, an adviser with Balasa Dinverno & Foltz LLC in Itasca, Ill., which manages $1.5 billion.  An ETF that invests in munis has been a long time coming. For years, industry experts have said that such a product would be difficult to create, because the muni market is more opaque and less liquid than other bond markets. The proposed ETF, however, gets around those problems because the index it plans to track won’t own the entire universe of muni bonds, said Matt Tucker, head of investment solutions at Barclays. The yet-to-be released index “applies a couple screens” to the broad market, he said. For example, it excludes securities that are below investment grade, Mr. Tucker said. The duration of the index will fluctuate along with the duration of the bonds outstanding, he said. But the possibility exists for the creation of more duration-specific indexes on which future muni-ETFs could be based, Mr. Tucker said. Mr. Appel said he’s OK with that solution. Barclays has built up a very good reputation, and whatever solution it hits upon to allow it to launch a muni ETF will be well thought out, he said. That may be true, but it doesn’t mean its success is assured. A key to success will be its expense ratio, said Sonya Morris, editor of Morningstar ETFInvestor, a newsletter published by Morningstar Inc. of Chicago. Barclays does not state the expense ratio in the prospectus for the proposed ETF. But it will have to be low — lower than those of similar mutual funds, Ms. Morris said. That could be difficult considering that The Vanguard Group Inc. of Malvern, Pa., currently offers muni bond funds with expense ratios as low as 0.9%. But even if the Barclays ETF is a little more expensive, it still could be successful, Mr. Appel said. Vanguard doesn’t make active trading easy in its funds, so an ETF that invests in munis would be attractive to active traders, he said. Even with a relatively low expense ratio, however, some advisers said they didn’t think they would be very interested in the proposed ETF. Illiquidity and opaqueness make munis one of the few areas where an active manager can make a difference, said Lewis J. Altfest, president of L.J. Altfest & Co. Inc. in New York, which manages $500 million. One adviser who uses Barclays’ fixed-income ETFs said he was coming around to that conclusion. Their performance has not been impressive, said Theodore J. Feight, president of Creative Financial Design, a financial advisory firm in Lansing, Mich. That’s largely because the bond market hasn’t performed well, he said. In such an environment, an active bond manager who has proven he can outperform the bond market may end up being more attractive than a passive ETF, said Mr. Feight, whose firm does not disclose assets under management. Of course, the proposed Barclays ETF isn’t just any passive ETF. It would give investors access to a market previously inaccessible via ETFs. “I would assume advisers looking at muni funds ought to be interested in this,” said Jim Lowell, Needham, Mass.-based editor of Forbes ETF Advisor, a monthly newsletter. He is developing his own line of ETFs.